Finding winners in a risk on/risk off world

Managed futures had another difficult year in 2013, and not only suffered a poor return environment spurred on by continued unprecedented government and central bank intervention but also by media attacks and costly regulations hitting at the worst time.

Last year we reported how the Barclay CTA Index experienced back-to-back negative years for the first time in its 35-year history. Make it three in-a-row as the index dropped 1.46% in 2013.

There is a consensus of opinion that the risk on/risk off nature of markets in recent years is to blame for the difficult environment of the last few years. Normal fundamentals drivers have taken a back seat to speculation on how the Federal Reserve will react to news, causing sharp reversals of trends, the bane of all trend-followers.

“Yes the markets have fundamentally changed and yes it has been a bad cycle,” says Thomas Rollinger principal at Red Rock Capital. “The forced zero interest rate policy and other government intervention in the markets created unique behavior that was troublesome for most.”

Dunn Capital Management President Martin Bergin says, “There is pretty good evidence that the risk on/risk off nature of markets [creates a difficult environment] for trend-followers. The worst case scenario has you make gradual profits and then have sharp reversals.”

Dunn, however, was one of the few more traditional trend-followers who performed well in 2013. Its benchmark WMA program earned 34.19%, its D’Best program earned 37.61% and its combined earned 57.74%.

As a short-term program Mosaic was the more likely strong performer, 41.44% in 2013, but the strategy had struggled in 2011 and 2102 as choppy markets damaged traders across the time spectrum.

BarclayHedge President Sol Waksman says, “A lot of it depends on your timeframe. If you are a shorter-term or [super long-term] trader you were ok, if you are in the middle somewhere you might have a problem.”

Waksman says the first few months of the year were decent but in the middle of the year trends were choppy and volatile.

Bergin attributes Dunn’s success to profitable trades in Asian financial markets early in the year and changes to its methodology that allowed them to keep more of those profits. Dunn does not alter its approach often but at the beginning of the year initiated its Adaptive Risk Profile that dynamically changes its risk exposure based on proprietary analysis. “We made 16% in February and didn’t give it back,” says Bergin. The question for every manager is, ‘How do you reduce volatility without reducing performance’ and this does it.”

It also highlights the difficulty in making assumptions in the trend-following space because despite the recent difficult environment there are trend-followers who managed to find a way to produce outsized returns.

Yet, as a whole, risk on/risk off made it a difficult year for trend-followers and the manager who did well concentrated on niche markets, avoided the chop by trading shorter-term and having the flexibility of discretion to avoid the wild swings.

Rollinger says, “Much of the choppiness seen by globally diversified trend followers is indeed linked to the risk on/risk off phenomenon. That phenomenon, however, has not been problematic in the long/short commodity space.”

About the Author

Editor-in-Chief of Futures Magazine, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange. Dan joined Futures in 2001 and in 2005 he was promoted to Managing Editor, responsible for overseeing all the content that went into Futures and futuresmag.com. Dan’s incisive reporting and no-holds barred commentary places him among the most recognized national media figures covering futures, derivative trading and alternative investments.